One of the big claims that the coalition made when they announced the spending cuts in 2010 was that we were all in this together. Since then, as public sector jobs have been lost and economic growth has stumbled, there have been many individual claims and counterclaims about the unfairness of the cuts, and their impact on both the rich and the poor. With Mitt Romney paying an overall tax rate of 15%, the question of whether the rich are really paying their share will be a key issue in the US election. And, with Chancellor Osborne recently announcing he was shocked by how some rich people pay just 10% income tax, and the Prime Minister apparently about to publish his own tax figures, this debate about tax fairness has now crossed the Atlantic.
At its heart, this debate is about the trade-off between fairness and opportunity. A simple starting point for fairness might be that everyone should pay the same overall tax rate. As an economist, I would actually argue strongly that a progressive taxation system where richer people pay more is justified, as the benefit anyone gets from extra income declines as we get richer (in the jargon, the marginal utility of income declines). So, from that stand point, rich people paying 10% income tax is clearly not on. As many ordinary people already suspect, often only the rich have access to the sorts of tax reduction schemes that end up with them paying so little in the first place. This, to most of us, is unfair.
However, at the same time there is a genuine debate to be had about whether high tax rates discourage people from trying to earn money. At the extreme, a 60% or 70% marginal tax rate could well be enough to convince rich people to work and earn a bit less, and enjoy more leisure time. And while money may not really buy happiness, it does buy you options. One issue that featured in last year’s debate about non-doms was the fact that they could just potentially move elsewhere – potentially leaving all of us worse off, if they took their money with them.
This links into another aspiration – the desire to rebalance the economy away from consumption and towards investment. Monetary policy can’t do this, but fiscal policy can try. An obvious mechanism would be to raise taxes on consumption (VAT) but cut taxes on investment (stamp duty on equities, capital gains tax). Unfortunately, one consequence of a lower tax rate on investments than on income is that rich people tend to benefit most. Workers on the median UK income of Â£21,093 will not own many shares – at best, many might be slowly buying their own home via the traditional means of paying off a mortgage. But, if we want to encourage rich people to invest in UK PLC by buying equities or corporate bonds (or even government bonds), we do have to bear in mind that capital is more mobile than labour – rich people could put their money somewhere else.
At the same time, some of the grander claims made about high tax rates hold little water. Once a country reaches a certain level of income (per capita), there is precious little sign that lower tax rates boost trend productivity growth, which is the ultimate driver of national income. Ireland’s experience in the 1990s is often cited as an example, but it is worth remembering that GDP per capita in the UK was 50% higher than in Ireland in 1989 – Ireland had some catching up to do. (China is doing the same thing now.) If you look at the historic productivity performance of the G7 over the past hundred years or so, there is precious little sign that the different tax and benefit regimes that were seen had much impact on trend productivity growth. Once you strip out changes in population and the cycle it is hard to see any link. The cut in the 50p tax rate will not boost long-term growth in the UK.
I am also regularly dismayed by the seeming unwillingness of some of the rich to pay more tax. There are notable, worthy exceptions. One of these is Warren Buffet, who has suggested that millionaires pay a minimum of 30%. Personally, I believe anyone rich enough to fall into that bracket can afford a 30% income (or dividend) tax. But I have met a great many people who think that they should not – for them, the notion of fairness is outweighed by their perceived (economic) benefit to society. For others, it can sometimes look all too easily like selfish money-grabbing. But, at the same time, I have friends on modest incomes who argue passionately for low taxes for the rich – in part, due to their aspirations to one day be rich themselves.
As fiscal consolidation continues, this issue is not going to go away. More and more people now realise that income inequality has jumped massively over the past thirty years or so, with no sign of any positive impact on trend growth or productivity. Even if inequality did start to reverse, which seems unlikely, it would take years to unwind. And, honourable exceptions aside, few of the rich are likely to endorse the Buffet rule.
While I am definitely not a millionaire, as an economist my salary is higher than the UK average. My own attitude on this topic was set several years ago; I was happy to pay higher taxes if it meant my grandmothers, both of whom came from very modest backgrounds, got to pay less. Even now that they have both passed away, I am still happy to pay more tax if it means a struggling family has to pay less. Massaging my tax rate down implicitly shifts the burden on to other people who on average are poorer than me, because my salary is above average. But, among the very rich, I sadly suspect any similar sense of solidarity is often missing.